Lexicon

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business model

This describes the method or means by which a company tries to capture value from its business. A business model may be based on many different aspects of a company, such as how it makes, distributes, prices or advertises its products. [1]

The business model concentrates on value creation. It describes a company's or organisation's core strategy to generate economic value, normally in the form of revenue. [2]

The model provides the basic template for a business to compete in the market place, it provides a template on how the firm is going to make money, and how the firm will work with internal players (firm’s employees and managers) and external players (stakeholders such as customers, suppliers, and investors).

The business model indicates how the firm will convert inputs (capital, raw materials and labour) into outputs (total value of goods produced) and make a return that is greater than the opportunity cost of capital and delivers a return to its investors. This means that a business model’s success is reflected in its ability to create returns that are greater than the (opportunity) cost of capital, invested by its shareholders and bondholders.

Business models are an essential part of strategy – they provide the fundamental link between product markets, within the industry, and the markets for the factors of production such as labour and capital.

Any resilient business model must be able to create and sustain returns for its investors over time, otherwise, it is likely to go out of business or fashion. [3]

ExampleThe 'razors and blades' model used by companies such as Gilette, in which a basic product (the razor) is sold cheaply, but an essential add-on or consumable (the blade) is sold at a high price once the customer has been lured in. [4]

Another example is a mobile phone company may sell handsets (the bait) at a reduced price while signing up customers to buy calls over the period of a contract (the hook). [5]

Also General Motors, for many years, had an unsustainable business model as its returns did not match or exceed its cost of capital. Profitability was focused on the financing of cars, i.e. providing financing to its automotive customers, such as loans to buy the cars, through its finance subsidiary GMAC, rather than by designing and manufacturing sought after cars that are also cost competitive.

When the financial crisis struck, this model encountered problems, and as GMAC had to seek a US government bailout, the company’s already precarious condition turned into bankruptcy. [6]